Let’s revisit some of these topics above from a different angle with a guest post by James DeMasi of Seraphin Group in response to a question I asked on the OSV facebook page.

“Name one lesson you learned in 2012 and how you are going to be a better investor for it in 2013?”

When Do I Sell Stocks?: Drawing Wisdom from Buffett to Zuckerberg

Every investor knows when to buy a stock. You buy when you believe that the stock is attractively priced relative to the price you believe is its true value.

On the other hand, selling can be a little trickier. Say you buy ABC stock for $25. You believe it will be worth $50 or more in three years. Three months after your initial purchase the stock rallies to $40. This isn’t uncommon and it makes many investors very nervous as they wonder, “What should I do now?”

A Common Scenario

The stock has not hit your intrinsic value target, but you’re holding a 60% gain only 3 months into your investment.

This is way sooner than you had expected and this kind of momentum could very well be unsustainable. You might consider taking the gain now and then buying it back when the stock dips, but how big of a dip is big enough?

Will you know? Is $37 acceptable? Should you wait for it to go lower than that? What if ABC never reaches your price point to rebuy? Could you ever possibly buy back in with a comfortable mindset?

As an investor, you’ve probably found yourself in this exact position more than once, so let’s talk about the solution. Forget the market for a second.

The only question to ask yourself here is, “Does selling make sense given everything I know about this company?”

Being able to answer this single question is essential and could quite possibly be difficult, because you might find that you don’t know as much about the company as you should.

Lessons on Conviction from Mark Zuckerbeg

Let’s turn to Mark Zuckerberg to illustrate just how powerful this one question can be.

In 2004, Friendster and an unnamed New York financier each made $10 million offers to buy Facebook. David Kirkpatrick wrote in The Facebook Effect that Zuckerberg, “didn’t for a minute think seriously about accepting,” these offers.

In 2005, Viacom’s MTV offered $75 million, which was also rejected.

In 2006, MTV, Yahoo, and AOL all made $1 billion-plus offers and were turned away.

Michael Wolf, CEO of MTV Networks told Bloomberg that Zuckerberg’s response to his $1.5 Billion offer was, “I think it’s worth a lot more… I may never have an idea as good as this so I’m not that interested in selling.”

Stick to Your Circle of Competence

At this point you may be beginning to understand why Buffett recommends that you stick to your circle of competence.

No one will ever know more about Facebook than its creator, Mark Zuckerberg. That level of in-depth knowledge brings the clarity and confidence that one would need in order to reject a $1.5 billion offer. He knew what he had and, as he said, he believed it was worth more.

Lo and behold the company now has a $60 billion market cap. If you don’t fully understand the business that you’re invested in then you will be reliant on the market to tell you what it’s worth, because, frankly, you don’t honestly know. Being in that type of position never allows for good decision making.

So when will Zuckerberg sell? Never. Buffett has also said that, “The best time to sell is never.” He went on to say, “Only buy something that you’d be perfectly happy to hold if the market shuts down for ten years.” Buffett is able to find companies that are worth holding onto indefinitely, because he makes sure to fully understand those businesses. This allows him to grasp the company’s long-term economics.

When you’re researching a possible investment then imagine that you are buying into a private company that will not IPO for at least 5 or more years. What would you want to know about that company before locking yourself into it? You’d probably want to know who the management are, what their qualifications are, what their business model is, what their competitive position is within their industry, what their prospects are, what their strengths, weaknesses, opportunities, and threats are, who their suppliers are, who are their customers are, and the list goes on.

But.. You are Not Buffett

Unfortunately, we cannot all be oracles like Buffet, and we may never know a company as well as its founder. Besides, businesses can and do change over time. As such, an infinite holding period may be more of a dream than a practical reality for most companies, especially as industries evolve at an ever more rapid rate. Therefore, we’ll conclude with the lessons of another great investor, Phil Fisher.

Philip Fisher’s Timeless Advice

In Fisher’s book, Common Stocks and Uncommon Profits, he advised that the right answer to the question “when do I sell stocks?” is when one or more of the following three conditions are met:

When you realize that your analysis was materially wrong.

When, due to the passage of time, the stock no longer qualifies as suitable investment according to his 15 scuttlebutt investment checklist. The most common reasons are management deterioration, managerial smugness, complacency, and exhausted growth possibilities.

When there is a better opportunity, BUT you must be absolutely 100% sure of your analysis. Having held your first stock for some time, you know everything there is to know about that company. That is almost never the case with a new investment. Therefore, your analysis must be completely sound and the difference in return must be substantial enough to justify a switch even after discounting the possibility of not being perfectly correct.

How would Fisher answer the original question about what to do with our $25 stock that rocketed to $40? I believe he would hold onto it. He said that selling in that position will make it too difficult to ever get back into it. Besides, if the company is truly innovative then you never know what else the future may hold.

In conclusion, legendary investor Joel Greenblatt said it best.

“Ideally, your decisions to buy or sell stocks should be based solely on the investment merits.”

Of course, you have to be brutally honest with yourself and your analysis. If after all that, you are sure that you own a great company that you understand and feel confident in then be like Zuckerberg and don’t settle. Remember, it takes time for those 3, 5, or 10+ baggers to evolve and for wealth to be created. Happy investing and may good fortune be forever in your favor.

About the Author

James DeMasi is an expert stock researcher, a proud member of the CFA Institute, and the founder of Seraphin Group, a registered investment advisory company. For more information on Seraphin Group visit http://SeraphinGroup.com or on Facebook at http://www.facebook.com/SeraphinGroup

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Old School Value is a suite of value investing tools designed to fatten your portfolio by identifying what stocks to buy and sell.

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